New Month -- Same Weak Euro

The US dollar has begun the new month off on strong footing against both and emerging market currencies. The yen is the sole exception.

There are three drivers today. The first is economic data from China and Europe that play on fears that the financial turmoil is taking a toll on the real economies. The second is continued concerns about European debt situation, with some speculation spread to France today. Third, political leadership is severely challenged. Japanese Prime Minister Hatayama is apparently considering stepping down and the President of Germany Koehler resigned yesterday and the deputy CDU leaders Roland Koch, and premier of the state of Hesse resigned last week. The net consequence is that the euro has been driven to a new low (since April 2006) and is now in the middle of the life-time range.

No currency seems unaffected by the rise of risk aversion. Even the Canadian dollar, which one would expect to be supported ahead of the central bank meeting that is widely expected to result in the first rate hike for a G7 country, is under pressure today.

This continues to be a poor environment for global equities. The MSCI Asia Pacific Index slipped 0.8%. News that China’s PMI fell to 53.9 from 55.7 in April, a somewhat larger than expected decline took its toll on commodity and share prices. European bourses are down even more, with most markets off at least 2%. Financials are among the weakest sectors not only in Spain, Italy, Portugal and Ireland, but also Germany and France. Weak commodity prices are weighing on basic materials and oil and gas shares as well. US indices are called around 1.5% lower.

Flight to safety is evident in the fixed income market. US Treasuries and German bunds are out performing, with 10-year yields off 5 bp. Peripheral European spreads are wider over Germany. So is the premium that France pays over Germany (3 bp wider today—a third of the year to day widening).

Separately, Chinese money market rates rose to 19-month highs today (key seven day repo rate jumped 69 bp to 3.2%). However, this is unlikely to be a harbinger of an official rate hike. Part of the pressure should ease after tomorrow’s CNY40 bln (~$5.9 bln) convertible note issuance by the Bank of China. Another part of the pressure is coming form the PBOC’s attempt to drain liquidity from the banking system. Today it sold half amount of T-bills it did a week ago (CNY15 bln) but at about an 8 bp higher yield (2.0096%). Lastly, as widely expected the Reserve Bank of Australia kept rates steady at 4.25% and the statement suggested a more neutral stance.